You could see that this week when Ben S. Bernanke, the Fed chairman, made his semiannual pilgrimage to Capitol Hill to discuss the state of the economy. Lawmakers voiced concern about possibly excessive regulation of banks, but not about the clearly inadequate capital the big banks — and many small ones — had before the crisis.
Some of them seemed to be upset that the Fed’s policies had caused stock prices to rise. Jeb Hensarling, the Texas Republican who is chairman of the House Financial Services Committee, seemed to think that all current economic problems could be traced to President Obama’s excessive spending.
He was upset that the “Federal Reserve has regrettably, in many ways, enabled this failed economic policy through a program of risky and unprecedented asset purchases.”
Mr. Bernanke, who is probably nearing the end of his tenure running the Fed, seemed to have had such criticisms in mind last week when he assessed “the first 100 years of the Federal Reserve” at a conference in Cambridge, Mass.
In analyzing the Fed’s failures during the Depression, he seemed to be taking clear aim at some of his current critics — and perhaps at other central banks that were far less aggressive after the credit crisis.
First, he appeared to address the idea, popular in some circles, that we need a new gold standard.
“The degree to which the gold standard actually constrained U.S. monetary policy during the early 1930s is debated,” he said, “but the gold standard philosophy clearly did not encourage the sort of highly expansionary policies that were needed.” He said policy makers, following flawed economic theories, concluded “on the basis of low nominal interest rates and low borrowings from the Fed that monetary policy was appropriately supportive and that further actions would be fruitless.”
Was that a criticism of the European Central Bank under Jean-Claude Trichet, which lowered interest rates but did little else as the euro zone crisis grew? It certainly helped to explain why Mr. Bernanke felt the need to embark on quantitative easing and to focus on longer-term interest rates as well as short-term ones.
Then Mr. Bernanke pointed to “another counterproductive doctrine: the so-called liquidationist view, that depressions perform a necessary cleansing function.” That was the view pushed in the early 1930s by Andrew Mellon, the Treasury secretary, to such an extent that it angered even President Herbert Hoover, who did not, however, seem to think he could overrule the secretary. Now the comments could be read as a reproach to those, in the United States and Europe, who push for austerity above all else.
“It may be that the Federal Reserve suffered less from lack of leadership in the 1930s than from the lack of an intellectual framework for understanding what was happening and what needed to be done,” Mr. Bernanke concluded.
It seems to me that something similar could be said for the Fed before the debt crisis erupted. The intellectual framework it used simply could not cope with the idea that financial stability can itself become a destabilizing factor, as investors and bankers conclude that it is safe to take on more and more risk.
For a time, the period before the collapse was known as the “Great Moderation,” a term that Mr. Bernanke helped to publicize in a 2004 speech. Low levels of inflation, long periods of economic growth and low levels of employment volatility were viewed as unquestioned proof of success.
And what brought on that success? In 2004, Mr. Bernanke, then a Fed governor, conceded good luck might have helped, but his view was that “improvements in monetary policy, though certainly not the only factor, have probably been an important source of the Great Moderation.”
In 2005, three Fed economists, Karen E. Dynan, Douglas W. Elmendorf and Daniel E. Sichel, proposed an additional explanation for the Great Moderation: the success of financial innovation.
“Improved assessment and pricing of risk, expanded lending to households without strong collateral, more widespread securitization of loans, and the development of markets for riskier corporate debt have enhanced the ability of households and businesses to borrow funds,” they wrote. “Greater use of credit could foster a reduction in economic volatility by lessening the sensitivity of household and business spending to downturns in income and cash flow.”
Floyd Norris writes on finance and the economy at nytimes.com/economix.
Article source: http://www.nytimes.com/2013/07/19/business/economy/when-bernanke-got-it-wrong.html?partner=rss&emc=rss
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